Wednesday, October 12, 2011

I watched most of last night's Republican debate. A few things were obvious: Perry is in over his head and no longer stands a chance; Cain continues to float up in standing; Gingrich was born to be an elder statesman, but not President; Paul is too dogmatic; and Romney is clearly the frontrunner.

Most of what Romney said I agree with, with two huge exceptions: his stance on China and his advocacy of lower capital gains taxes for the middle class.

Romney said that "if he were elected president he would immediately launch a combative relationship with Chinese leaders and attack their currency and trade policies." I wouldn't mind seeing him elected, but I sure hope that before he takes office, someone tells him he is dead wrong on China.

I sense that these words resonated with a lot of folks, and that's very unfortunate. Romney's great weakness as a leader is that he is a slick politician who crafts a message that he thinks people like to hear. He may understand a lot about how businesses and economies work, but he has no grounding at all in trade policy.

For those who disagree, let me first say there is a huge body of research, backed by sound economic theory, that says that free trade is an unmitigated good: no exceptions. Second, let me note that imports from China are such a small part of what we buy that trying to correct our supposed trade imbalance with China can't possibly be worth the risk of starting a trade war with such an important trade partner.

Goods and services from China accounted for only 2.7% of U.S. personal consumption expenditures in 2010, of which less than half reflected the actual costs of Chinese imports. The rest went to U.S. businesses and workers transporting, selling, and marketing goods carrying the "Made in China" label. Although the fraction is higher when the imported content of goods made in the United States is considered, Chinese imports still make up only a small share of total U.S. consumer spending.

Third, let me quote from the excellent Don Beaudreaux, who, in an open letter to Romney, demolished Romney's position using simple logic:

... you complained that Beijing pursues policies that make Chinese products less expensive than American products.

I overlook the fact that, because only 2.7 percent of Americans’ personal consumption expenditures are on goods and services produced in China, 97.3 percent of the goods and services bought by American consumers obviously are less expensive to Americans than are Chinese-made equivalents.

Instead, let me here go to the heart of your argument and accept your presumption that party A harms party B if A offers to sell goods or services to B at prices lower than what it would cost B to produce those goods or services himself.
Accepting this presumption, I’m obliged to advise you that you can make yourself and your family better off by styling your own hair. Your current stylist obviously does a fine job – strong evidence in support of my suspicion that that stylist has pursued policies that make it less costly for you to use his or her styling services than it would be for you to design and maintain your coiffure yourself.

If that's not enough, because you think that it's China's subsidizing of its exports that is harmful to us, consider this open letter written by Boudreaux to Robert Samuelson:

You argue that we Americans are harmed by foreign subsidies that lower the prices of our imports (“Our one-sided trade war with China,” Oct. 7). But why? Why are we harmed by these lower-priced imports if (as I know you agree) we benefit from imports whose prices are lowered by natural market forces?

In both cases, some U.S. workers lose jobs. And in both cases, not only does Americans’ cost of living fall, but, also, opportunities are thereby opened in America for the creation of new industries and new opportunities that would otherwise be economically out of reach. In America, absolutely nothing about jobs lost to imports whose prices are made lower by foreign subsidies distinguishes them from jobs lost to imports whose prices are made lower by natural market forces.

If you’re skeptical of my claim, ask first: Would you oppose the successful private efforts of a Chinese physician to invent an inexpensive pill that safely and completely cures people of cancer? I’m sure not, despite the fact that such a pill would destroy many American jobs – from those of physicians to hospital orderlies. Now ask, would you oppose the successful efforts of the Chinese government to subsidize the invention and production of such a pill for export to America?

The logic of your position is that such subsidies would hurt Americans and, therefore, Uncle Sam should retaliate with measures to protect us from the scourge of such a low-priced cancer-curing pill.

But honestly, would Americans really be made better off by retaliatory tariffs that prevent us from buying this pill – or that force up the price of this pill to levels sufficient to protect the jobs of oncology physicians, nurses, and other health-care workers? If you (rightly) suspect that the answer is no, then you should realize that your case for retaliatory trade restrictions against whatever goods Beijing might now subsidize for export is without merit.

I would also refer skeptics to my post "Pity the Chinese" from last October, in which I note that China is the losing party in our trade relationship:

They sell us mountains of cheap goods, then turn around and invest most of the proceeds (equivalent to our trade deficit with China) in U.S. Treasury securities. We get the goods, and we get to keep the money. Then we devalue the dollar, and they lose on their investment. Why we would want them to stop doing this is beyond me, though if I were a Chinese citizen, I would be furious with my government for directing such massive quantities of my country's export earnings to Treasuries.

As for Romney's preference to further steepen our already-very-progressive tax code, by giving those who earn less than $200,000 a reduced capital gains tax rate, let me say that I am fed up with politicians discriminating among us on the basis of race, ethnic origin, or income, or whatever. Income redistribution of the kind Romney is advocating is morally wrong (think Robin Hood), and it does nothing to strengthen our economy or advance living standards in general. In fact, it most likely harms the economy by creating perverse incentives that distort the allocation of the economy's scarce resources. Furthermore, steepening the tax code further only makes it more difficult for those who are climbing the income ladder, since it creates very high marginal tax rates.

UPDATE: I think it's appropriate here to include a few words from Art Laffer, who adds weight to the argument against raising taxes (which also applies to not lowering taxes, or increasing the progressively of the tax code) on upper income earners:

It has become an article of faith among the proponents of “soak the rich” policies that the wealthy are somehow immune to tax rate hikes. We hear a lot of cynics arguing that increasing tax rates from 35 to 39.6 percent won’t affect the behavior of hedge fund managers and CEOs, since these high achievers are allegedly out to win status, not just an income.

As usual, these critics have things exactly backwards. It’s the poor and middle class who are largely unresponsive to income tax rate changes. The person who punches the clock at a 9-to-5 job has few options when tax incentives change. Upper income earners, on the other hand—particularly entrepreneurs—have much more leeway to change the timing, location, and composition of their income. To give a simple example, a blue collar worker can’t easily strike a deal with his boss to take his pay for calendar 2012 as a lump sum payment in December 2011, to avoid a looming tax rate increase. But businesses engage in analogous arrangements all the time. That’s why we see the Laffer Curve give its most pronounced effects when it comes to changes in the capital gains tax rate.

It’s ironic that so many of Obama’s supporters deny that income tax incentives can influence behavior. After all, most of them are ardent supporters of a carbon tax to reduce carbon emissions to fight the threat of climate change. For some reason, in this context they understand full well that when you tax an activity, you get less of it. Well, the same applies to earning income. When you raise the marginal tax rate on the most productive members of society, expect less output, fewer jobs created, and a smaller bounce in tax receipts than a naïve static analysis would have suggested.

22 comments:

mcgrannis: "For those who disagree, let me first say there is a huge body of research, backed by sound economic theory, that says that free trade is an unmitigated good: no exceptions."

This is not accurate. Adam Smith, David Ricardo, and other right-leaning economists advocated retaliatory tarriffs against mercantilists because they realized that one-sided trade deals with mercantilists can growth the world's economic pie, but nevertheles shrink the slice for the losing side. And China, India, and Japan all have protectionist regulations and laws to tilt the scales in favor of locals. You can see this from ag with restrictions on rice (eg, Japanese love California rice but there's restrictions on it), and so on.

The US cut many one-sided trade deals over the past 40 years in order to fight communism. If you read public memoranda by the Departments of State and Treasury regarding many treaties, you can see the beurocrats basically admitting to this trade off in order to further foreign policy goals.

I'm not taking sides, just pointing out that trade isn't just about efficiency gains by enlarging the pie, it is also about distribution issues about dividing up the pie. If you're a utilitarian thinking that it's OK to reduce the US middle class' standard of living in order to better the standard of living for the third world middle class, let's have that debate in the open.

There is tremendous amount of wealth disparity in the society because of deregulation and we're asking for more deregulation: this makes no sense to me. Although it makes sense to think like that if I'm the top 1%.

May I remind you that the wealth that was generated over the last decade was done on the backs of middle class getting into more debt?

It should also be added that free trade is not fair trade, in the sense that there is perpetual trade imbalances: http://www.census.gov/foreign-trade/balance/c5700.html

This further leads people to think mistakenly that it is due to currency pegging by the Chinese, whereas these exporting countries who are exporting useful goods don't want to import deflation in return.

I like the idea--give people a stake in the system, a feeling they too can profit by investing.

On China, I don't know. The real world conforms to no theories, it just is what it is. Mercantile nations, supported by pro-business governments and pro-growth central banks, have flourished, including S Korea and China, but earlier Japan (until the Bank of Japan choked off growth, permanently).

I do like the idea of letting the yuan float, and in a free market it should.

Some have posited that rising wages and living standards in China, a less-friendly Communist Chinese government, and a lack of rival manufacturing platforms means this problem will solve itself within 10 years. Made in the USA may come back.

Add on to that, we pay for imports with money we print. Not a bad trade.

Supposing you're right about the effects of currency and subsidies (even though it ignores the fact that China subsidizes until they control the market, e.g., rare earths), but what about the theft of intellectual property, including military and industrial espionage? Your focus only on the economics of our bilateral relationship ignores the reality: China leeches off the U.S. They will such us dry if we let them. Better to make a stand now while we hold the upper hand.

Scott - love your blog. On China I agree with some of your points but I think some of the comparisons are too shallow. For example the hairstyling and cancer pill - I get the point, but every situation is not the same. How about this analogy - China offers to sell us all of our military hardware for half the price that we can make it. Sounds great... Until a few decades pass, we fundamentally lose the ability to make those items, and suddenly we are at the mercy of China to keep our defense capabilities. Over time we will lose the ability and infrastructure to make those products. This may be okay for textiles, but what about microchips or cars? I don't support a trade war and I think these China issues will gradually resolve themselves since they are already appreciating the Yuan and inflation is higher over there. But I do see the argument that we need to have some rules about fair competition.

SDH: Thanks for your thoughtful comment. But you seem to be assuming that when China sells us something they are doing it in an artificial manner and perhaps with sinister long-term goals. Suppose, however, that the yuan is allowed to float, and China removes all capital controls, and yet the yuan continues to trade around recent levels. No one could then argue that China is artificially depressing the yuan to gain a trade advantage. If China still offers to sell us cheap goods, including military equipment, is it their fault if we become dependent on something that threatens our national security?

Maybe it's the case that China is simply an excellent competitor, and it is producing goods and services for less than we can do it ourselves. What then is wrong with us buying those cheap goods? Would you refuse to eat a meal at McDonald's because you thought their hamburgers were too cheap?

I agree with Scott's analysis on China, and his criticism of Romney's pandering as well. This cap gains proposal is a perfect example of why he can't get above 25% among likely GOP voters. We've had three flavors of the month now seriously challege or overtake Mitt precisely b/c GOP voters instinctively know that he has no authentic core and will take part in any deal as long as it gets him past the finish line.

Let's remember too that we are are a good 4-5 months before the first serious primary takes place (SC). Not one vote has been cast yet. Romney is the clear frontrunner only in the eyes of the media, both mainstream and 'conservative.'. But these guys are usually wrong in their prognostications, so take Mitt's "lead" with a healthy dose of skepticism,

@Vbounded: your argument is based on two 18th century economic writers. why not include Maltus while you are at it. Also neither Smith or Ricardo made empirical test (BTW neither considered themselves economist).

Now, where Mr. Grannis makes an error is that in most free trade analysis there is the concept of compensating the losers (even then everyone gains). The problem for America over the past two decades is that we have learned the first part of free trade, but forgotten the second part...

Squire: don't kid yourself. The media, protecting Romney now by trying to destroy Perry as they did their best to destroy Bachmann, will turn on a dime if he gets the nomination and pursue him as viciously or more as they did in 2008 to their former GOP sweetheart, McCain. And only a small percentage of Democrats will be tempted by Romney or any other 'moderate' GOP candidate.

In this cycle, Obama's disapproval ratings are so high and are so baked into the cake, that any of the Big Three right now -- Cain, Romney, and Perry -- would win in a walk. But they won't win b/c of Democrats crossing over, even if the nominee gets a bit more than the usual crossover vote; the nominee will win b/c Republican turnout this time will revert to norm and a huge swath of the independent vote will pull the lever for the GOP.

Re China's "unfree" currency. Pegging one's currency is a perfectly legitimate monetary policy, and China has been doing that for some 18 years. There is no reason to think the economy hasn't fully adjusted to the level of the yuan, and thus there is no reason to thing that the yuan is "too strong" or "too weak." If anything, given the ongoing revaluation of the yuan, it could be the case that the economy has not fully adjusted to the relative strength of the yuan, and therefore it might be said that the yuan is "too strong."

But those who say that by pegging the yuan that China is a manipulator do not understand that this practice is simply how China chooses to implement monetary policy.

If the U.S. quit having deficits then China would have too many dollars and nowhere to put them. They would have to increase the value of their yuan in an attempt to reduce the inflow of dollars they can’t place. That would be better than being blamed for a trade war.

I China is only exercising their monteary perogatives I would argue the U.S. should do the same for the benefit of the U.S.

>Jon S. I am thinking not that Democrats will vote for a Republican for president but that some will stay home and not vote. Voter suppression. You sure are right about the media attacking the new Republican president.

Squire: yes, I think a decent number of Democrats will stay home this time and not vote, hopefully equal to the number of Republicans who stayed home last time in 2008 -- a not insignificant number. My guess is they will stay home no matter who the GOP nominee is, b/c the level of discontent is extraordinarily high among many liberal groups.

Not a voter suppression thing, though, b/c as I said earlier if Romney gets the nomination the media will turn him into the second coming of Attila the Hun. Disenchanted libs will stay home no matter who the nominee is. In any event it won't matter all that much b/c the Republicans will turn out en masse and the independents will vote GOP this time. I won't be surprised if the GOP nominee carries 40+ states.

Scott-I agree with your free trade and tax analysis. Re: the GOP primary, Romney is not a conservative and will not get the Tea Party vote in the primary (lukewarm in the general). Perry and Bachmann are not ready for prime time, Newt is an internationalist who has no moral compass and is distrusted by the Tea Party, and Huntsman, Santorum, & Johnson have no base of support. Paul has only libertarians in his camp. That leaves Cain who appears to be the only viable conservative who will have tea party support and can appeal to Independents and even a few Democrats. If he does not stumble, Cain will do well in IA and win SC and FL. If he can overcome the money disadvantage in the rest of the states to beat the GOP "establishment" choice of Romney in the primary, it will be Cain vs. Unable in the general. I like that match up.